Corporate Update

SEC Adopts Mandatory Proxy Access Rules

On August 25, 2010, the Securities and Exchange Commission (the “SEC”) adopted rules requiring public companies to include director nominees of significant, long-term shareholders in the company’s proxy materials. According to the SEC, this mandatory “proxy access” is intended to “facilitate the ability of shareholders to exercise their traditional rights under state law to nominate and elect members to company boards of directors.” The SEC approved the new rules by a vote of 3 to 2, with Commissioners Casey and Paredes dissenting.

The question of shareholder proxy access has been a topic of debate among the members of the investment community for many years. The SEC proposed amendments to the proxy rules relating to proxy access three times in the last decade (2003, 2007 and 2009). In addition to other concerns, the authority of the SEC to amend the proxy rules was recently raised as an issue. The recent passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amended Section 14 of the Exchange Act of 1934, as amended (the “Exchange Act”) thereby authorizing, but not requiring, the SEC to make amendments to the federal proxy rules permitting proxy access. The adopting release is available here.

Highlights of the rule changes include:

• Providing an annual 30-day window during which eligible shareholders or shareholder groups may submit director nominations for inclusion in a company’s proxy materials;
  
• Requiring the inclusion in a company’s proxy materials of shareholder nominees constituting up to 25% of the board;
  
• Permitting shareholders (or shareholder groups) holding securities constituting at least 3% of the company’s voting power continuously for three years to make such nominations; and
  
• Requiring public companies to include in their proxy materials shareholder proposals seeking to establish a procedure in the company’s governing documents for the inclusion of shareholder nominees in the company’s proxy materials.

The following is a summary of noteworthy provisions from the new rules. It is not intended to be an exhaustive analysis of the changes effected by the new rules.

I. Shareholder Nominee Proxy Access

A. Companies Required to Provide Proxy Access

New Rule 14a-11 applies to all Exchange Act reporting companies, including investment companies and voluntary reporting companies, but does not apply to companies that have only registered debt securities. Smaller reporting companies will not be required to comply during the first three years after effectiveness of the rule, during which time the SEC staff will monitor the implementation of the rules by larger companies and consider whether changes to the rule might be required for smaller reporting companies. Foreign private issuers will not be subject to Rule 14a-11. Public companies whose governing documents do not permit equity holders to nominate directors, or to elect directors (such as some public limited partnerships), will also not be required to comply with the rule.

B. No Opt-Out Permitted

Companies subject to Rule 14a-11 will not be able to opt-out, regardless of whether a company’s governing documents prohibit the inclusion of shareholder nominees in the company’s proxy materials. However, a company may adopt amendments to its governing documents that provide for greater proxy access than required by Rule 14a-11. For example, a company’s governing documents could require a lower ownership threshold or a shorter holding period than imposed by Rule 14a-11.

C. Nominating Shareholder Eligibility

Shareholders will be eligible to have their nominee(s) included in the company’s proxy materials if the shareholder (or group) satisfies all of the following eligibility requirements:

• 3% Voting Power Ownership. The nominating shareholder (or group) must own at least 3% of the total voting power of the company’s securities. The rules allow shareholders to aggregate holdings to meet this threshold. It should be noted that borrowed shares do not count toward the ownership threshold, short positions are required to be netted, and shares loaned out will only count if the shareholder has the right to recall the loaned shares and will do so if the nominating shareholder’s nominee is included in the company’s proxy materials. Ownership for the purposes of Rule 14a-11 requires that the shareholder (or group) have both the power to vote and to dispose of the securities (as opposed to Rule 13d-3, which defines beneficial ownership as the possession of either voting or dispositive power). If the nominating shareholder is not the record holder of the securities, it must provide a written statement from the person (such as a bank or broker) through which such securities are held, verifying the nominating shareholder’s ownership.
  
• Three-Year Holding Period. The nominating shareholder (or group) must have held the required amount of securities continuously for at least three years, and will be required to continue to own at least the required amount of securities through the date of the shareholder meeting at which directors are elected.
  
• Absence of Change of Control Purpose. The nominating shareholder (or group) must certify that it does not hold the company’s securities for the purpose of effecting a change in control or to gain a number of seats on the board of directors that exceeds the number of shareholder nominees a company could be required to include in its proxy materials under the new Rule 14a-11. In addition, the nominating shareholder cannot be a member of any group engaged in soliciting or other nominating activities in connection with the subject election, cannot separately conduct a proxy solicitation (other than an exempt solicitation with respect to its nominees included pursuant to Rule 14a-11) and cannot participate in another person’s solicitation in connection with the subject election.
  
• No Agreements with the Company. The nominating shareholder must not have any agreement with the Company with respect to the nomination of the nominee. However, unsuccessful negotiations with the company with respect to the nomination of a nominee do not constitute a disqualifying agreement.

D. Nominee Eligibility

Each nominee is required to satisfy the following conditions:

• No Violations of Law or Stock Exchange Rules. The nominee’s candidacy or, if elected, board membership must not violate applicable federal laws, state laws or applicable exchange requirements (other than requirements regarding director independence).
  
• Nominee Must Meet Objective Independence Requirements. The nominee must satisfy objective independence standards of the applicable national securities exchange or national securities association. Neither the subjective determination of independence required by a securities exchange nor any enhanced independence standards contained in a company’s governing documents need be taken into account for this requirement. Nominees for directors of investment companies must not be “interested persons” as defined in the Investment Company Act of 1940.
  
• No Agreements with the Company; Relationships with Nominating Shareholder Permitted. The nominee may not have any agreement with the company regarding the nomination. However, the rule does not impose any limits on the relationship between the nominating shareholder (or group) and the nominee, although such relationships must be disclosed.

E. Number of Nominated Directors

Under Rule 14a-11(d), a company will be required to include in its proxy materials the greater of one shareholder nominee or the number of shareholder nominees that represent 25% of the company’s entire board of directors (rounding down if 25% of the board is not a whole number). In the case of a staggered board, the rule provides that the 25% limit will be calculated based on the total number of board seats, not the lesser number that are being voted on at the subject meeting. Directors nominated by a shareholder (or group) under the rule and elected at a prior meeting who hold office continuing after the coming election (i.e. directors on a staggered board) would count toward such limits. For companies with dual classes of stock that have different voting rights, the 25% requirement applies to the entire board (for classes that vote together in the election of all directors) or to the portion of the board the particular class is entitled to elect (for companies where a certain number of board seats are reserved to certain classes). Nominees who are included in the company’s proxy statement after negotiation with the company will count against the 25% limit so long as the nominating shareholder filed its notice on Schedule 14N prior to commencing discussions with the company.

F. Priority of Nominees

• Multiple Shareholders Submit Nominees. Under Rule 14a-11(e)(1), if a company receives multiple qualifying nominations, the company will be required to include in its proxy materials the nominee(s) of the nominating shareholder (or group) with the highest qualifying voting power. If that shareholder (or group) does not nominate the maximum number of directors, the nominee(s) of the nominating shareholder (or group) of the next highest qualifying voting power would be included, and so forth, until the maximum number of nominees is reached.
  
• Nominating Shareholder Withdrawal or Disqualification. Under Rule 14a-11(e)(2), if a nominating shareholder (or group) withdraws or is disqualified before the company has commenced printing its proxy materials, but after the company has given notice to the nominating shareholder (or group) of the company’s intent to include its nominee(s) in the company’s proxy materials, the company will be required to include in its proxy materials the nominee(s) of the nominating shareholder (or group) with the next highest voting percentage that is eligible, if any. If the company has commenced printing its proxy materials, then the company will not be required to include a nominee in its proxy materials.
  
• Nominee Withdrawal or Disqualification. Under Rule 14a-11(e)(3) if a nominee withdraws or is disqualified after the company provides notice to the nominating shareholder (or group) of the company’s intent to include the nominee in its proxy materials, the company will be required to include in its proxy materials any other eligible nominee submitted by that nominating shareholder (or group). If that nominating shareholder (or group) did not include any other nominees in its notice filed on Schedule 14N, then the company will be required to include the nominee(s) of the nominating shareholder (or group) with the next highest voting power percentage that is otherwise eligible, if any, until the maximum number of nominees is reached. If the company has commenced printing its proxy materials, then the company will not be required to include a nominee in its proxy materials.

G. Shareholder Notice on Schedule 14N

A nominating shareholder (or group) must provide a notice to the company on Schedule 14N if it intends to include its director nominee or nominees in the company’s proxy statement. This notice on Schedule 14N must be transmitted to the company and filed electronically with the SEC on the same date. Schedule 14N will require, among other things, the following information:

• information with respect to the nominating shareholder (or group), including name and address of such shareholder(s), the amount and percentage of the voting power of securities held by the nominating shareholder (or group) and the length of time that such securities have been held;
  
• information with respect to the nominee(s), including biographical information, a description of relationships between the nominee(s) and the company and the nominees and the nominating shareholder (or group), and a statement regarding whether the nominee meets the company’s director independence and director qualification standards;
  
• a statement of the nominating shareholder’s (or group’s) intent to hold those securities through the meeting at which directors will be elected and disclosure regarding the shareholder’s (or group’s) intent to hold those securities after such meeting (which may be contingent on results of the election of directors);
  
• a certification that the nominating shareholder (or group) does not intend to seek to gain control of the board or to gain a number of seats on the board that is more than the number of nominees a company could be required to include in its proxy materials under Rule 14a-11; and
  
• several certifications relating to eligibility and the accuracy of the information provided in the Schedule 14N.

This notice must be submitted to the company and the SEC not more than 150 nor less than 120 days before the first anniversary of the date that the prior year’s proxy materials were first mailed to shareholders. The relevant dates for such submission must be disclosed in the company’s proxy statement or, if the company did not hold an annual meeting the prior year or has changed the date of its annual meeting by more than 30 days from the prior year, in a Current Report on Form 8-K.

H. Exclusion of Nominees; No-Action Request

A company will not be required to include a nominee(s) in its proxy materials if it determines that the nominating shareholder (or group) or nominee(s) fails to satisfy the eligibility requirements of Rule 14a-11; however, a company must notify both the nominating shareholder and the SEC if it makes such a determination. If the company desires the SEC’s view on its determination, the company may request a “no-action” letter from the SEC staff with respect to its determination to exclude the nominee. In addition, a company can exclude a nominating shareholder’s (or group’s) statement of support if the statement exceeds the 500 words per nominee maximum and may seek a no-action letter from the staff with regard to this determination if it so desires. When discussing this process at the SEC’s open meeting announcing the adoption of the new rules, the SEC staff made assurances that all no-action requests will be reviewed and decisions issued in a timely fashion to provide each company the guidance it needs to make eligibility determinations under the new rule.

I. Timing of Process

If a company determines to include a nominee in its proxy materials, the company must notify the nominating shareholder (or group) no later than 30 days before the company files its definitive proxy statement with the SEC.

The rules also outline a process to be followed in the event that a company determines that it could exclude a nominee from the proxy materials. A general description of the process and timing follows:

II. Exemption from Proxy Solicitation Rules for Communications by Nominating Shareholders

The SEC has adopted a limited exemption from the proxy rules for communications made in connection with using Rule 14a-11.

• Formation of a Group. Rule 14a-2(b)(7) provides an exemption from the requirements of the proxy rules for solicitation by or on behalf of any shareholder in connection with the formation of a nominating shareholder group, under certain circumstances, so long as the soliciting shareholder limits the information contained in its written communications and files such written communications with the SEC under Schedule 14N. In the case of oral communications made pursuant to Rule 14a-2(b)(7), the nominating shareholder must file a cover page in the form of Schedule 14N at the commencement of the oral solicitation.
  
• Solicitation of Support for Shareholder Nominee(s). Rule 14a-2(b)(8) provides an exemption to the proxy solicitation rules for solicitation by or on behalf of a nominating shareholder (or group) in support of its nominee who is included or will be in the company’s form of proxy provided that: (i) the soliciting party does not seek to act as a proxy, and does not furnish or otherwise request a form of revocation, abstention, consent or authorization; and (ii) any communications contain a description of the nominating shareholder (or group), and a legend directing shareholders to the company’s proxy statement.

III. Shareholder Proposals Relating to Nomination Procedures

The SEC adopted amendments to Rule 14a-8(i)(8) such that companies may no longer rely on such rule to exclude from their proxy materials qualifying shareholder proposals to amend a company’s governing documents regarding nomination procedures or disclosures related to shareholder nominations. Shareholders (or groups) making such proposals would need to satisfy the ownership and certain other procedural requirements of Rule 14a-8. Companies will be entitled to exclude proposals that conflict with Rule 14a-11 or applicable state law or relate to particular elections and nominations for directors (such as the disqualification, election or removal of a specific nominee or director).

IV. Other Rule Changes

A. Liability for Statements Relating to Shareholder Nominees

The SEC has adopted amendments to Rule 14a-9 providing that a nominating shareholder (or group) will be liable for any false or misleading statements it makes regarding the nomination, regardless of whether the statements are included in the company’s proxy materials. Rule 14a-11(f) includes explicit language that a company will not be held responsible for any information provided by the shareholder and then reproduced in the company’s proxy materials.

B. Preliminary Proxy Statement Not Required

The inclusion of a shareholder nominee in the company’s proxy materials pursuant to Rule 14a-11, an applicable state or foreign law provision, or a provision of the company’s governing documents would not require a preliminary proxy filing, even if the company opposes the shareholder nominee and solicits against the shareholder nominee and in favor of a company nominee, provided that the company was otherwise qualified to file directly in definitive form.

C. New Item 5.07 of Form 8-K

The new proxy rules impose the following Form 8-K filing obligations:

• If a company did not hold an annual meeting during the prior year, or if the date of the annual meeting has changed by more than 30 days from the prior year, a company must file a Form 8-K, within 4 business days after the company determines the anticipated meeting date, disclosing the date by which a nominating shareholder (or group) must submit notice to include nominee in the company’s proxy materials pursuant to Rule 14a-11;
  
• A company must file a Form 8-K disclosing the date by which a nominating shareholder (or group) must submit notice to include nominee in the company’s proxy materials pursuant to an applicable state or foreign law provision, or a provision in the company’s governing documents disclosing the date by which a nominating shareholder must submit Schedule 14N required pursuant to Rule 14a-18; and
  
• A registered investment company that is a series company is now required to file a Form 8-K disclosing the total number of the company’s shares that are outstanding and entitled to vote for the election of directors at the shareholder meeting as of the end of the most recent calendar quarter.
  

D. No Exemption from Section 16

There is no exemption from Section 16 requirements for shareholder groups formed solely for the purpose of nominating a director pursuant to Rule 14a-11. The SEC staff believes that because the ownership threshold for Rule 14a-11 eligibility is significantly less than 10%, shareholders will be able to form groups with holdings sufficient to meet the Rule 14a-11 ownership threshold without reaching the Section 16 threshold. Thus, the SEC concluded that Section 16 requirements will not be a deterrent to the use of Rule 14a-11 and no exemption is needed.

E. Exemption from Schedule 13D Requirements

The SEC staff realized that some nominating shareholders could inadvertently trigger reporting requirements under Regulation 13D when aggregating their shares to meet the Rule 14a-11 ownership threshold requirement. The SEC staff considered this concern and determined that a nominating group that is formed as a result of its activities in connection with Rule 14a-11, and that holds more than 5% of the shares of a company, would be eligible to use Schedule 13G to report its beneficial ownership, provided that its activities are limited to those contemplated by Rule 14a-11. The nominating shareholder (or group), however must continue to reassess its eligibility to continue to report on Schedule 13G as a passive or qualified institutional investor after the election.

F. Affiliate Status

The SEC did not adopt a “safe harbor” provision excluding a nominating shareholder (or group) from being deemed an “affiliate” of the company under the Securities Act of 1933 or Exchange Act solely as a result of using Rule 14a-11. Shareholders (or groups) who use Rule 14a-11 will need to apply a facts and circumstances analysis to determine their affiliate status.

V. Effective Date

The new rules will become effective 60 days after their publication in the Federal Register. If the effective date of the new rules is more than 120 days prior to anniversary date the company’s 2010 proxy materials were released to the shareholders, the company will be subject to the new rules at its 2011 annual meeting. For example, if the new rules become effective on November 1, 2010, a company will be subject to the new rules if it mailed its proxy materials for its last annual meeting no earlier than March 1, 2010.

VI. Review of Company Governance Documents Recommended

The new rules may present conflicts with some companies’ governance documents, particularly advance notice bylaws and/or recently adopted shareholder proxy access bylaws. We recommend that companies review their existing governance documents for possible conflicts with the new rules.